Financial Stability in European Banking: The Role of Common Factors
AbstractIn this paper, I investigate the development and determinants of CDS spreads for 18 major European banks between December 2001 and January 2004 using daily data. I demonstrate that two nonstationary common factors can be extracted from the data that together explain most CDS spread variation across time and across banks. The group of German banks plus a few Southern-European banks appear to systematically have high CDS spreads and to be relatively sensitive to changes in the underlying factors. The dominating first common factor impacts on all banks in a similar direction, suggesting strong market integration. However, the quantitatively less important second factor has opposite effects on credit spreads of Southern European versus Northern European banks, suggesting some remaining country-specific or region-specific credit risk. Finally, I show that the first common factor may indeed be interpreted as a measure of market conditions as it is cointegrated with the European P/E ratio and the 2-year nominal interest rate
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Bibliographic InfoPaper provided by Money Macro and Finance Research Group in its series Money Macro and Finance (MMF) Research Group Conference 2006 with number 101.
Date of creation: 02 Feb 2007
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credit default swap spreads; contagion; cointegration; factor analysis;
Other versions of this item:
- Clemens Kool, 2006. "Financial Stability in European Banking: The Role of Common Factors," Open Economies Review, Springer, vol. 17(4), pages 525-540, December.
- Clemens Kool, 2006. "Financial Stability in European Banking: The Role of Common Factors," Working Papers 06-13, Utrecht School of Economics.
- G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2007-04-09 (All new papers)
- NEP-BAN-2007-04-09 (Banking)
- NEP-EEC-2007-04-09 (European Economics)
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